Thoughts on the Election

A lot of investors are now accepting that Trump will win the election, with a good probability of a Republican sweep of Congress.  I agree with the Wall St. consensus that Trump wins.  Harris is just not a popular candidate, and has much less name value than Trump.  Add to the fact that she's the VP under an unpopular President in Biden, who helped usher in a very high inflation period.  And she's a black female, which makes it the worst demographic to get elected for President in the US.  

Contrary to what many Democrats believe, white candidates have a built in racial edge over black candidates.  Male candidates have a built in gender edge over female candidates.  There is a reason that you've never had a female US President.  And you've had one black President, who only got elected because he ran against a female primary candidate and during a severe recession under a Republican White House, guaranteeing a Democrat win in the 2008 election.  

Harris will get the anti-Trump vote, and the Democratic vote, but she won't get much of the independent vote because of the above reasons.  Overall, it looks like Harris is very likely to lose, although I would still give her about a 10-15% chance of winning because the polls are close.  But I think polls still underestimate Trump's support because there are still lots of shy Trump voters who don't like to admit that they are voting for him because of his un-Presidential behavior, and he isn't politically correct.   

Under a Trump presidency, the Trump tax cuts get extended, some tax cuts are possible, some additional tariffs (unlikely as much as Trump threatens), and less immigration = slower population growth and labor force growth.  This will increase the fiscal deficit, increase inflation due to a combination of lower taxes and fewer workers, and lead to higher bond yields.  It seems some investors are jumping the gun, looking at history, and thinking a Trump win will be a repeat of his first term, when you had a roaring bull market in stocks.  This is only feasible if you have blockbuster earnings growth (unlikely without another Covid era money spew) or have a further expansion in valuations on top of already historically nosebleed levels.  All while bond yields stay high due to the inflationary impact of loose fiscal policy/higher tariffs/tighter immigration.  Odds are high that the next 4 years in the stock market are nothing like 2017-2020. 

Under Trump's easy money fiscal policy regime, demand is artificially increased which creates higher growth.  That higher demand has 2 release valves.  One is through the bond market.  The other is through the currency market.  If the Fed decides to stay vigilant against inflation by reacting to higher inflation with higher interest rates, then bonds become the release valve of this high pressure economy.  Yields go higher.  If the Fed decides to ignore the higher inflation, then the currency becomes the release valve.  Financial repression through negative real interest rates will weaken the dollar, leading to even higher inflation in a vicious loop that will cause a bear steepening of the yield curve.  Of course, if the Fed restarts QE, then the bear steepening is suppressed, at the cost of further dollar weakness. 

In the first higher yields scenario, you get higher bond yields and lower stock prices.  In the second financial repression, weaker dollar scenario, you have a wildcard.  It is hard to predict how that affects the stock market.  If commodities skyrockets along with inflation, that will make stock market investors nervous, and you could see earnings go up but valuations drop hard.  If inflation doesn't get raging hot like 2021/2022, then you could see stocks go up along with a weaker dollar. 

Powell will be Fed chair for at least the next year, and if he's a lame duck as would be expected under a Trump presidency, he will no longer have to play politics and will focus more on his legacy, thus try to keep inflation under control.  He will become more hawkish as a result.  If the stock market isn't in an entrenched downtrend, I would expect Fed funds rates to stay higher than what the STIRs market is anticipating, meaning that you should see only 2-3 more rate hikes from now till the end of 2025.  That will eventually catch up to the bond market, as the maturity wall for corporate bonds will be coming in 2025 and 2026.  Corporations will have to refinance at much higher yields than previously, and interest expense will continue to creep higher.  

I expect the stock market to eventually readjust to a return of a tighter Fed in 2025 by going down.  It may take a few months for this to happen as the initial economic bump up from having Trump elected should keep the stock market buoyant.  By the 2nd half of 2025, this short term Trump adrenaline shot will have to face the new monetary reality.  At that point, a 2nd half 2025 waterfall decline in an overvalued, overowned SPX will be matter of when, not if. 

You likely get a reprieve from hawkish monetary policy in 2026 if Trump does what I expect him to do, which is replace Powell with a dovish lackey for Fed chair.  But the financial markets are so short term focused that its not even worth thinking about till right before the Fed renomination decision. 

The longer term effect of a high deficit, negative real rates policy under Trump is political change.  There will be a different US president in 2028, and by that time, raging high inflation will cause immense pain to the bottom half of the population.  That would basically be handing the Democrats the keys to the White House and Congress in 2028.  Controlling inflation will be the priority among the masses and that will be when the Fed has to make a hawkish turn to accommodate public opinion.  A Democrat sweep will be waiting in the wings, and it will be accompanied with higher taxes and higher interest rates.  Again, this is a much longer term consequence of what is likely to happen over the next 4 years and is not something that is market actionable.  

It appears that the late Friday selloff was due to the telegraphing of an Israel strike on Iran over the weekend.  The unwind of the afternoon selloff has happened overnight, and we're right back to no-man's land.  This is a level in the SPX where neither longs nor shorts have much edge.  Although given my belief that there will be a Republican sweep in next week's election, I would rather be long than short from now till then.  Ahead of big events, the financial markets have a tendency to front run the expected result and squeeze out much of the post move juice that would have happened without the front running.  

I was hoping for a move lower ahead of the election on the uncertainty but too many investors have FOMO, and don't want to miss a rally on a Trump win, which most investors expect.  I got out of all shorts last week, on that small dip.  Seasonal weakness is now behind us, and after tech earnings this week, the corporate buyback window is wide open.  

It is tough to find a real edge here, because if there was a 100% probability of a Trump win, I would go long, but that's not the case.  There is some small probability of a Harris win, and that potential downside keeps me from chasing longs here.  I think its a bit late to be short here with the election only a week away.  Some may question the premise that a Trump win would be good for the stock market, and I agree long term.  Especially if bond yields remain high in 2025, which would be bearish for stocks next year.  But over the short term, the vol crush after a big event like a Presidential election being over would be enough to squeeze the SPX higher for at least a few days.  Even with bullish expectations that you have going into it.  

Bottom line, its not a good risk/reward spot for either longs or shorts for both stocks and bonds.  Some may be tempted to try to buy the correction in Treasuries but I see little upside near term there, and there could be one last reflexive dump in bonds after a Trump win.  If that happens, I would consider buying Treasuries for a short term trade.  Right now, I don't see much edge.  In the case that you get a move towards SPX 5750 this week, I would be a buyer of that dip.  Otherwise, likely to be on the sidelines.